Tag Archives: business cycles

Wednesday Doom Parade

Today’s Mises Daily suggests we’re at a tipping point. 

David Stockman predicts and “epochal deflation” in a recent interview at CNBC.

The WSJ also points to China and commodity markets as cause for concern.

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Sneak peek of part one of my talk tomorrow

These are some points I’ve prepared for my talk tomorrow on inflation and business cycles in the Sound Money seminar at the Mises Institute. I decided to explain the topic of inflation by comparing the two main conceptions of inflation: rising prices and an increased money supply. The latter turns out to be more tractable and appropriate.


The word “inflation” means different things to different people. One popular conception of inflation focuses on prices—all prices, actually. For these people, including some economists, “inflation” means a rise in the general price level. The goods and services we buy have higher price tags. The other conception of inflation focuses on the money supply. Economists with this focus think of inflation as an increase in the amount of money in the economy.

We’ll see that viewing inflation as a rise in prices can be misleading and ambiguous especially compared to viewing inflation as an increase in the money supply.

First of all, prices can rise for many reasons: If the demand for something increases relative to its supply, or if the supply of something decreases relative to the demand for it, the price will increase. The fundamental reason for this is called diminishing marginal utility—increasing our stock of some good means that it will go toward the satisfaction of a lower-ranked end.

If the next “marginal unit” goes toward a lower-ranked end, then the most we are willing to pay for the next unit must be less than the previous unit. You might be willing to pay $600 for one Apple Watch, but the most you would be willing to pay for another might be $100, maybe as gift for somebody else or so that you could have one on both of your wrists!

Even though this sounds pretty limiting in terms of the reasons prices can rise, these two concepts—supply and demand—can and do channel all sorts of changes in the market. Preferences can change, goods can go in and out of fashion, accidents can happen that reduce our supply of a certain good, we can think of new and more efficient ways of producing goods, services that at one time could only be done with human labor can be replaced or complemented with new tools and machines, and so on.

The list of things that affect supply and demand is infinite, depending on how specific you get, but the important thing to remember is that all of these sorts of changes are integrated into and channeled through our preferences and ideas and therefore supply and demand.

Secondly, there is really no good way to measure a general rise in the price level. You maybe familiar with indexes like the Consumer Price Index, which are calculated and compiled based on survey data and technical mathematical methods, but by their very nature they cannot appropriately capture the price level. They cannot do so because these sorts of indexes are one number. They try to boil the trillions of pieces of data on the prices of all goods and services in the economy down to just one piece of data. Market prices, which are a complicated phenomenon on their own, fluctuate not only year to year, but month to month, day by day, and even second to second. Also, there is no central repository of price information.

Even in one country, prices emerge in a very scattered, decentralized way, from the halls of Washington D.C. to the dark, back alleys of downtown Chicago; from the lots of car dealers with neon paint to hand-to-hand-to-pocket tips for bellhops and restaurant servers; from fleeting ones and zeroes soaring at light speed across the internet to long-term contracts for land use or film production. One number couldn’t even begin to describe the magnitude and dynamic nature of something like the “price level”.

It would be like driving out West for a camping trip and going to the remotest location at night to view the stars and a meteor shower and then the next month, when you return to civilization and cell service you text your parents what the view was like and say, “Cool.”

Price index information is delayed, incomplete, and by its very nature incapable of describing the astronomical picture of market prices. And we haven’t even mentioned the well-cited issues with surveys, government data, and the more specific issues with the particular measurements.

A third issue with viewing inflation only as a rise in the price level is that it stops short of explaining the full consequences of monetary inflation. Many people correctly understand the relationship between the price level and the money supply—more money means higher prices—and they also understand that this relationship is bad for the average Joe. Now, Dr. Salerno is not average by any measure, but we can say that if he is one of the later receivers of new money, he has to pay higher prices before his own salary increases due to inflation, however you define it. In this way, inflation is not harmless—it represents a wealth transfer to the first users of the new money from the later users of new money as it ripples through the economy.

Even though most people know and understand this consequence of increasing the money supply, it stops short of explaining the full consequences of monetary inflation, which will be developed in the second part of my talk on the business cycle.

But to summarize, viewing inflation as a rise in the price level has at least three main problems: it is ambiguous because almost anything can change prices, it is impractical because it can’t be appropriately measured, and it is incomplete because it doesn’t tell the whole story of increases in the money supply. Inflation is more appropriately viewed as an increase in the money supply, and this conception of inflation does not suffer the same problems as the other. Monetary inflation has a simple, well-defined cause, unlike price inflation. Monetary inflation is measureable because money is its own unit of account and can be counted up, unlike price inflation, which is not directly measureable. Monetary inflation is also the starting point for the business cycle story, instead of a stopping point for many, like price inflation.

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Interest and Education

I have this idea that’s been in the back of my mind for maybe a year now, that involves the decision to prolong education and the influence of interest rates on that decision. I would be interested in comments on these ideas, as they are very undeveloped. Yesterday’s post on Production and Interest summarizes the basic theory behind an entrepreneur’s decision to either engage in production or lend. It turns out that the expected returns to each alternative will tend to equalize because of the effect of increasing or decreasing supply and/or demand in factor markets and credit markets. The decision to continue education is similar, but different.

The following train of thought assumes that students borrow to finance their education and that staying in school and working are mutually exclusive. A student can cease their education and supply labor on the market or they can continue their education and not only increase their future productivity, but also their specificity. Each option may be the opportunity cost of the other, so at some point, continuing education has diminishing returns and the opportunity cost–earning a wage–exceeds the benefits of staying in school and so the student leaves the education system for the workforce. If we assume that students borrow to finance their schooling, then low interest rates (not artificial) would encourage staying in school longer, getting more advanced degrees, and therefore becoming a more specific and productive future laborer.

Artificially low interest rates may have an ambiguous effect on students’ decisions to stay in school. Low interest rates make borrowing cheaper, but also increase the opportunity cost of staying in school because of the economy-wide propped-up wages induced by the artificial boom.

This still isn’t thought all the way through, but I imagine there is something to be said about malinvestments in the education system due to artificially low interest rates. Entire academic fields may get a “bump” or university administration salaries and positions may surge because of a combination of both monetary policy and government spending and regulation in education, just like other bubbles have been fueled and directed by similar combinations in the past (see housing and tech).

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Woods, Salerno, White, Selgin, and Wenzel in a spat

Somebody whose last name starts with “S” needs to continue this WSWSW pattern.

Tom Woods interviewed Joseph Salerno on the wrong-headed economics associated with NGDP targeting, a monetary policy prescription usually associated with so-called “market monetarism”, even if it has deeper Keynesian roots under the surface. Larry White, who has over the years been associated with Austrian economists, sometimes as a comrade-in-arms, sometimes just as a fellow traveler, but other times (like this time) as a sore thumb, recently proposed NGDP targeting in an interview as a viable and prudent policy prescription. George Selgin, who seems to take things very personally even though he was only mentioned briefly in the interview, wrote up a cranky blog post about how wrong Salerno was to criticize such a policy and the monetarist/Keynesian analysis that leads to such a conclusion, even bringing Hayek to battle (reminds me of how Dan Sanchez said libertarians on social media call on the big names like throwing a Poke ball in a Pokemon battle). Salerno and Wenzel parried each of Selgin’s attacks, including a remark on how Hayek had rebuked NGDP targeting-type policies in Prices and Production.

As a Salernian (see the brilliant last line of Peter Klein’s afterword to Salerno’s new festschrift), I hold to the standard Austrian dictum: Any artificial increase in the stock of money via credit markets triggers a business cycle. I may be able to add a bit on price stickiness, however, since it comes up a lot in these discussions. The “stickiness” of prices is a choice variable. Prices and wages are just as sticky as the market actors proposing and accepting the prices want them to be. Wage contracts may be fixed for longer periods of time, but it’s because the wage earners and payers agree to such an arrangement. Gas stations with digital signs may be able to adjust their prices with the push of a button. This same technology is even used by department stores like Kohl’s and other firms. Voluntary price stickiness shouldn’t be an issue, especially as internet and digital pricing make their way into regular use. Price controls, government regulation, and taxation are notable cases of involuntary price stickiness, the effects of which would be discoordinating.

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